The United States Constitution requires a relationship between an activity and a state before the state can tax the activity. If the taxable activity is part of a unitary business, the combined income of the unitary business is subject to apportionment.
Apportionable income is sourced to the various states/countries where a business is conducted compared to nonapportionable income, which is specifically allocated to a state or country. Therefore, it’s important to understand the difference between the two.
Apportionable income can be any type or class of income and can result from any activity that meets either the “transactional test” or the “functional test”. For example, apportionable income can include interest, dividends, and gains on investments of working capital, as well as investment income on sinking funds, and income from other investments needed to satisfy creditors or future needs of the business.
The “transactional test” provides that if income arises from a transaction or activity in the regular course of your business, the income is apportionable income. For example, interest and gains derived from investments of working capital are transactions in the regular course of business.
The “functional test” provides that if you acquire, manage, or dispose of property and this activity is an “integral part” of your regular trade or business operations, the income from the activity is apportionable income. For example, a manufacturing company acquires, uses, and disposes of tangible as well as intangible assets as part of its regular operations. Although the sale of a manufacturing facility may occur infrequently, this type of transaction does occur during the normal course of operating a manufacturing business.
Nonapportionable income is all income other than apportionable income. It’s allocated to the specific state where it was earned. If the income is from intangible assets, it’s typically allocated to the state of the corporation’s commercial domicile or the principal place from which the trade or business is directed or managed. Nonapportionable income is also referred to as allocable income and must be offset by the deductions relating to its production.